The Insolvency and Bankruptcy Code (IBC)1 is considered as one of the landmark economic reforms of the country. It consolidated the fragmented insolvency framework into a single law. It is in sync with the international practices which was evident from the meteoric jump of India in the Ease of Doing Business index from 130 in 2016 to 63 in 2020.2 The recoveries under IBC have been the maximum with the recovery rate of 23.8% as compared to other modes like the SARFAESI Act3 and the DRT Act4.5 But not everything is efficient and clear with the Code, and it has been faced with its own set of complexities and ambiguities.
One such issue is the perplexity attached with the creation of inter se priority among the secured creditors under the Code. Though IBC confers general priority to the secured creditors in repayment along with the workmen dues, it is silent on the inter se priority among the secured creditors in case of them holding different level of charges. This issue has been addressed and debated by the BLRC (Bankruptcy Law Reforms Committee) and the ILC (Insolvency Law Committee) in their reports but still the uncertainty persists. Even the courts and the tribunals have interpreted this aspect differently adding to confusion.
This essay aims to analyse the provisions governing the status of the secured creditors under the Code and the issues surrounding the inter se priority of such creditors. It aims to understand the legislative intention through the BLRC and ILC reports. The essay also delves into the international jurisprudence governing this issue and analyses how the various judgments of the Supreme Court and the tribunals have misinterpreted the Code and have deviated from the objective of the Code. The last limb of the essay tries to provide some recommendations to resolve this conundrum and propose some concrete solutions.
Debt recovery mechanism for secured creditors: The legal transition
The debt recovery mechanism has never been a straight way for the secured creditors which was instead governed more by the customs of the credit market and the business practices of inter-credit agreements. Nevertheless, it is interesting to note that both Section 2(16) of the Companies Act, 20136 and Section 3(4) of IBC7 define “charge” as an interest or a lien created on the property or assets of a company, or any of its undertakings or both as security. As such a charge created by the company can be an exclusive charge or a pari passu charge or a subordinate/priority charge.8
Before the Code came into effect the concept of priority of claims of secured creditors was also recognised by other statutes. Section 48 of the Transfer of Property Act, 18829 provided that if a person attempts to transfer rights in the same immovable property at different times and these rights cannot coexist or be fully exercised together, any rights created later will be subject to the rights established earlier, unless there is a specific contract (e.g. inter-creditor agreement) or reservation favouring the later transferees. The first charge-holder’s claim takes priority over the second charge-holder, and in cases where debts are owed to both, the first charge-holder must be repaid before the second charge-holder. The same rationale was adopted by the commercial laws of the country which recognise the priority rights of the secured creditors including the Companies Act, 201310 and the SARFAESI Act.11
The reasoning which was soundly based on national laws and international practices was further adopted during the drafting of the IBC. In this respect, BLRC acknowledged the priority rights of secured creditors and emphasised that these rights should be established through a distinct provision.12 Furthermore, the recommendation holds that the first charge-holder be granted the authority to assert claims that were in existence at the time when the security interest was created.13 This recommendation later came to be incorporated as Section 53 of IBC which provides for the liquidation waterfall providing priority to the secured creditors along with the workmen’s dues.14 But no mention of inter se priority among the secured creditors themselves, instead backfired to the benign intentions of the lawmakers, creating ambiguity among the first charge or priority charge-holders with regard to their claims. Further, Section 53(2) empowered the liquidator to disregard contractual arrangements between the creditors, thereby jeopardising the inter-creditor agreements.15
The alternative remedy available for such dissenting financial creditors is to enforce their security as per Section 52 to satisfy its debt. The lack of priority to high charge-holders in Section 53 pushes them to realise their debt by separately enforcing their security outside the liquidation estate. The provision in such case provides for two methods:
(a) secured creditors who relinquish their security interest to the liquidation estate are entitled to receive proceeds from the sale of such assets in priority along with the workmen’s’ dues; and
(b) secured creditors who realise their security interest in the manner provided in Section 52 of the Code can claim their unpaid debts under Section 53(1)(e) which stands at lower priority in comparison to secured creditors who has relinquished their security interest in the liquidation estate.16
The secured creditors who chose to enforce the security interest can do so as per Section 52 of the Code. Regulation 37 of the Liquidation Process Regulations17 provides for the manner in which secured creditor can realise its security interest either through mechanisms provided under IBC or securitisation application under SARFAESI Act.
Even in case of the corporate insolvency resolution process (CIRP), the protection to the secured creditors was attempted to be extended through the Amendment of 201918 by ensuring the payments to the dissenting financial creditors not be less than the amount due to them in case of a notional liquidation.19 Therefore, the treatment of dissenting financial creditors is based on a “notional liquidation value” (calculated as on the insolvency commencement date). Such treatment in light of lack of clarity about the priority of charges and security interest keeps the choice for the financial creditor at a guess estimate, whether to assent or dissent from the resolution plan.
Hence, it can be observed that the status of the charge which the secured creditors possess is not duly applied in the Code and hence this creates a Pandora’s box for the courts and tribunals to interpret the claims of different secured creditors in various manners subject to the facts and circumstances of the case. Such uncertainty frustrates the purpose of the Code which is the revival and value maximisation of the assets of the company.
Position of exclusive owners: An evolving jurisprudence
The theoretical conundrum
The law for priority of charges is quite clear in Indian jurisprudence thanks to the basic common law notion of doctrine of priority. However, the problem is still unresolved when it comes to the inter se priority of charges between the secured creditors in liquidation proceedings. The ambiguity created by the law led to the rise of two schools of thought with respect to the classification of the secured creditors — first charge holder/exclusive owners and second/later charge-holders.20
The first school of thought is cardinally based on the doctrine of equitability, thus consolidating the priority rights of the exclusive owners over any other charge-holder over the security. It is interesting to note that while the pre-insolvency rights and the general credit culture support this theoretical division, this school of thought takes security interest and not the value of the debt into consideration, thus raising a criticism on this ground. Nonetheless, it is important to understand that the division is in accordance with the principles of legality. Furthermore, the later charge-holders who are aware of the exclusive ownership and the distribution of rights have the option of enforcing contractual rights through entering into inter-creditor agreements.21
On the other hand, the second school of thought believes in a construction based on the linkage of credit with security. While acknowledging the priority rights of the secured creditors, it rejects the inter se priority division, thus propounding a similar treatment to all the creditors who are linked by a common collateral. The main reason for such a contrary interpretation stems from the fear of breaking down of the group solution proposed by the resolution process and failure of its corporate revival objective.22 The fear, nonetheless, has instead created a confusion which is still being resolved by both the judicial bodies and the specialised tribunals (NCLTs/NCLAT), thus opening the door to many reasonings, adding to the conundrum.
Diverging views of the judiciary on rights of first charge-holders
The insolvency jurisprudence of India is largely silent on the inter se priority rights of the secured creditors, thus saying a little on the classification of the secured creditors as well. Nevertheless, the courts have strived to provide a solution by interpreting the law majorly based on the aforementioned two schools of thought. In this respect, the line of decisions can also be divided into two based on the different schools of thought preferred in the reasoning. In the beginning, the first school of thought was preferred due to the positivist approach as well to keep up with the customs of credit market.23 However, it is interesting that this line of reasoning was adopted by the newly formed NCLTs which gave more consideration to the security interest.24
Initially the Supreme Court was also inclined towards this school of reasoning which is evident by its judgment in Essar Steel (India) Ltd. v. Satish Kumar Gupta.25 However, the stance soon changed in Amit Metaliks case which is often considered as the turning point in the evolving jurisprudence on pre-insolvency rights. It was held by the Court that the legislative intention behind the Amendment of 2019 was not to give any special right to the dissenting financial creditors but to give an equitable treatment.26 The case redefined the doctrine of priority in accordance with the second school of thought to hold that the principle of equitability requires that equal treatment should be given to all the creditors during the CIRP process. While secured creditors can still enforce their security under Section 30(2)(b), a significant change has been made in their pre-insolvency rights and the status of exclusive ownership.27
Furthermore, it is pertinent to understand that during the CIRP process, the dissent by the secured creditors is a result of the resolution proceeds being less than the liquidation value. Nevertheless, the Supreme Court instead of resolving the problem of less resolution value of the assets and incentivisation to the creditors, chose to curtail the priority rights of the exclusive owners. A detrimental effect which went unseen was the conferring of precedence value to the decision, thus making it the new law binding on both NCLTs and NCLATs. However, an effort was made by the NCLT, Ahmedabad in the case of Gujarat Oleo Chem Ltd., where it was held that the charges are sequential and not proportional.28 The case is instrumental in the sense that it gave effect to the first school of thought even in the presence of the precedential value of Amit Metaliks29 judgment.30
Nevertheless, it is important to know that the NCLT, Ahmedabad relied on the Bombay High Court decision31 which precedes the IBC provisions and is more relatable to the doctrine of priority given under the Companies Act, 1956.32 While the judgment of the NCLT has no precedential value given it was overturned by the appellate body33 it is wrong to point that the blunder committed by the Supreme Court is not rectifiable. However, the Supreme Court which is still adamant on its position to uphold the revival objective of IBC is not able to see the legislative intent as well as the economic value of the law.34 In this regard, the value maximisation object of the amendment of 2019 has been overlooked which has proved to be costly to the secured creditors. While a chance is still present to make things correct and clear in the ongoing case of SASF v. Technology Development Board355, it is unlikely that the Supreme Court will prefer first school of thought and upheld the inter se priority rights of the exclusive owners, thereby necessitating suitable legal amendments to correct the law than to rely upon the diverging jurisprudence given by the courts and tribunals.
Priority rights to secured creditors: An international perspective
While the Supreme Court and the tribunals are evolving the jurisprudence on the priority mechanism to the secured creditors, the legal limitations imposed on the secured creditors should also be analysed by the best international practices to resolve uncertainties. Furthermore, the spirit of IBC is largely derived from the international insolvency regimes like that of UNCITRAL model law and English insolvency laws.36 In this regard, the priority rights of the secured creditors with respect to their collaterals are even recognised by the World Bank to ensure greater predictability.37 The similar position has been taken in terms of principle of equitable treatment which is even emphasised by the BLRC which led to the enactment of the IBC.38
It is a common notion around the globe irrespective of the insolvency regime that creditors of the same nature or with similar rights should be treated similarly. From this perspective, the UNCITRAL legislative guide provides for three approaches to deal with secured creditors.39 The first approach is based on the libertarian principles, giving the creditors freedom to enforce their security through other mechanisms thereby depriving them of voting rights during the resolution process. The second approach based on group solution approach, instead prefers to the creation of a separate class for exclusive creditors. The third approach supplements the first approach by letting the creditors with unsatisfied claims vote like unsecured creditors to recover the remaining claims. It is interesting that the IBC though has adopted some aspects of the first approach, the law is unique for its approach towards the secured creditors during the CIRP process.
While the insolvency regime provides for another debt recovery method under SARFAESI Act for both CIRP and liquidation procedure, one should note that the remaining claims can be addressed by the IBC only in the case of relinquishment.40 Nevertheless, the law is opposed to the second approach and the doctrine of equitability by considering both the exclusive charge-holders and second charge holders in the same category.41
If seen from the view of the US bankruptcy laws, Chapter 11 of the US Bankruptcy Code provides for the bifurcation of the creditors into secured and unsecured based on their claims.42 The Code though being debtor-centric provides for liberty to the creditors to be not bound by the plan unless right of retention of the security interest or proceeds has been given to the them.43 Further, the Code under Section 1129 provides for the retention of the lien and right to receive deferred payments equal to the present value of the security.44 When compared to the creditor-centric laws of India, the position is more flexible, certain and in conformance to the international principles.
Similarly, the UK position is also quite clear in protecting the priority rights of the secured creditors by restricting the administrator’s power to hinder the enforcement of the securities during the resolution45 and protecting the open choice of securitisation during the liquidation.46 Moreover, the secured creditors participating in the resolution process even though dissenting are protected under the UK Companies Act as per which the dissenting creditors should be satisfied through a settlement or compromise which is beneficial or neutral to their interests.47
Therefore, in principle the international position is clear on protecting the priority and exclusive rights of the secured creditors. While it might be contended that the majoritarian principles enshrined in the IBC and the ultimate objective of the revival of the company makes the voices of the dissenting creditors and priority creditors feel less, the creditor-centric approach of the regime coupled with the international position calls for more certainty in the position. In this respect, it should be noted that like the US Code, UK laws and EU Directives48, IBC also provides for at least liquidation value of the dissenting financial creditors.49 However, with the evolving jurisprudence and adverse and uncertain judgments, the law has been made practically invisible.
Towards clarity: The way forward
The existing insolvency framework for the secured creditors under the IBC is quite restricted and vague. While the Code is dynamic in nature and provides enough to cover most aspects of the “creditor-in-control” model, the exclusive owners or first charge holders are still deprived of the priority rights which are given by both international laws and credit customs.50 A major hinderance towards this goal is the lack of clarity due to the evolving as well as diverging jurisprudence of the Supreme Court and NCLTs.51 In this respect, though the need of clarity is suggested by many practitioners in this area, following structural reforms along with constructive reasoning are needed to bring the balance between the object of the law and welfare of all the secured creditors.
Valuation of the security to ascertain the secured portion of the creditors
The legislative intent behind Section 52 can be inferred to give options to the secured creditors, mainly the exclusive charge-holders, thus not binding by the liquidation procedure of the IBC. Nevertheless, the economic analysis suggests that the secured creditors will make a rational choice by referring to the liquidation value and the resolution value.
While the current regime provides an extensive regulatory framework for the calculation of the security interest by involving the information utilities,52 no longer necessitating registration of the charges,53 it is still unclear about the valuation of the security interest. In this regard, Irani Committee in 2005 had suggested to take the international practices into account to encourage greater legal predictability54 and the BLRC Report recommended making of a separate provision to deal with the first charge-holders and valuing the security from the date of creation of charge.55
Furthermore, ILC though supported the priority rights of the exclusive owners in the event of relinquishment did not recommend any legal change.56 However, from the current legal developments it is quite clear that the hopes of the ILC on the courts to give correct interpretation have gone wrong, thereby requiring legal intervention. The necessity is not only supported by the turbulence created by different lines of reasoning adopted by the courts but also by the unrests among the stakeholders, which has the potential to endanger the investor market of the country.57 Therefore, it is suggested that an Explanation be added to Section 53 to clarify that the security only extends to the undervalue of their security interest while the rest will be treated at par with the unsecured creditors.
Priority rights to the first charge-holders
In the commercial world, the importance of the pre-insolvency rights lies in the inter-creditor agreements which govern the inter se priority rights among the secured creditors.58 It is often argued that the protection of the junior charge-holders is equally important as per the doctrine of equitable treatment which is one of the reasons for the support towards the second school of thought.
For that purpose, two-fold arguments can be put forth. First, the junior charge-holders are subordinate to the first charge-holders or exclusive creditors, thus requiring unequal treatment among the secured creditors under the principle of equitability. Second, it is a general practice that the junior charge-holders are well informed while entering into the agreement.59 Nonetheless, IBC provides for some relief through Section 52 where the junior charge-holders will be satisfied after the satisfaction of the first charge-holder under the doctrine of priority. Moreover, a harmonious interpretation of IBC and the Section 48 of the Transfer of Property Act implies that the intention of the lawmakers was never to deprive the first charge-holders.60
The problem has even been reiterated by the ILC in its both 201861 and 2020 Reports,62 thus requiring a legal intervention by introducing an amendment in Section 53(2) with respect to validity of the inter-creditor agreements and for clarifying the priority rights of the first charge-holders which are wrongly interpreted in the course of time.
Creation of new class of creditors
It is interesting to note that the Indian insolvency regime in contrary to the international regimes, concentrates more on the security debts than on the security interests.63 This is more evident from the diverging jurisprudence on the status of the secured creditors which has instead led to confusion and fall in the investor welfare. While support from Parliament was provided to the dissenting financial creditors through the Amendment of 2019 to incorporate the doctrine of equitability, this has instead proved detrimental to the interests of the exclusive charge-holders thanks to the wrong and wide interpretation given to the provisions of the law.
Therefore, for a clear and correct application of the doctrine of equitability, it is pertinent to classify the secured creditors into sub-categories on the basis of not only the nature of the debt but also the valuation of the security interest. This will be beneficial in two ways — (a) it serves the object of the law by ensuring the welfare of every stakeholder on the basis of their debt and security interest; and (b) it makes the application of the waterfall mechanism under Section 53 easier and more clear. Furthermore, it will serve as an incentive to the secured creditors (especially the first charge-holders) who are assured of the proper treatment, to participate more actively in the resolution process.
Value maximisation and incentive creation
For the sake of promoting the welfare of every stakeholder, Section 30(2)(b) provides for the method of “notional liquidation”. If seen from the economic lens, a secured creditor will make a rational choice while choosing between resolution and withdrawal by considering the factors resolution value (R) and liquidation value (L) in the bargain. If R< L, then the creditor will opt to invoke the notional liquidation and receive more than he might have gotten in the CIRP proceedings. Through a mathematical analysis, it can be inferred that in such a situation, the value of the assets has gone down. This situation is not only detrimental to the proceedings where the creditors will hinder the process to invoke the notional liquidation as was highlighted by the Supreme Court64 but also adverse to the welfare of the creditors, thereby failing the object of IBC.
While the market prices of the assets cannot be controlled, a simple economic solution to the problem can be a higher reward mechanism to incentivise the creditors towards the resolution proceedings than notional liquidation. Therefore, in case of R< L at the time of notional liquidation, it is suggested that the payment should not be less than what the creditors may have received if the waterfall mechanism of distribution had been applied. However, in the case of R>L, the notional liquidation should instead govern the minimum entitlement. In this regard, though the MCA Discussion Paper65 proposes certain amendments and provides for the distribution of the surplus in a ratable manner, it is silent on the manner of distribution when the plan value is lower than the liquidation value.
The main intention behind the enactment of IBC was not only to consolidate and reform the insolvency regime of the nation but also to boost the investing sentiments by providing better and balanced rights to both debtor and creditor. However, the object will be left unfulfilled until the dilemma regarding the secured creditors and their priority rights remains unsettled. Although it is acknowledged that the lawmakers in the course of six years have tried many times to extend the protection to the secured and dissenting creditors to make their case stronger, the gaps in the law have led the courts to give an opposite interpretation. In this sense, while many recommendations had been and are given through this essay, it is essential that suitable rectifications are made to this dangling position by the combined efforts of lawmakers and the courts and reach a clear outcome aiming towards the principal agenda of investor protection and upholding prevailing business practices across the globe.
†4th year student at Gujarat National Law University (GNLU). Author can be reached at email@example.com.
††4th year student at Gujarat National Law University (GNLU). Author can be reached at firstname.lastname@example.org.
2. Aditya Kaushik, “Is IBC 2016 Effective?”, NITI Aayog (2020).
5. Reserve Bank of India, Report on Trend and Progress in Banking 2021-2022 (2022).
12. Bankruptcy Law Reforms Committee, Interim Report (February 2015).
13. Bankruptcy Law Reforms Committee, Interim Report (February 2015) p. 97.
20. Vijay Kumar Singh, “Modern Corporate Insolvency Regime in India: A Review”, (2021) 7 NLS Bus L Rev 22, 50.
21. Reshma, A., “Enforcement of Security under the SARFAESI Act”, (2010) 4 NUALS LJ 136.
22. Ajanta Gupta and Ritesh Kavdia, “Demystifying the Position of Secured Creditors Under the Code in IBC: Idea, Impressions and Implementations”, (2022) IBBI p. 93.
27. Suharsh Sinha, “Dilution of Secured Creditors Rights under the Indian Insolvency Regime”, (blogs.law.ox.ac.uk dt. 22-6-2022).
35. Stressed Asset Stabilisation Fund v. Technology Development Board , CA No. 2206/2021 (XVII) (SC) or Civil Appeal Diary No. 11060 of 2021.
36. M.P. Ram Mohan and Vishakha Raj, “Insolvency Set-offs in India: A Comparative Perspective” (IIM Ahmedabad, Working Paper No. 2021-06-01, 10-06-2021).
37. World Bank, Principles for Effective Insolvency and Creditor/Debtor Regimes 26 (IBRD/World Bank, 2021).
38. Shivangi Agarwal and Bhavya Singhvi, “Creditor-Controlled Insolvency and Firm Financing — Evidence from India”, (2023) 54 Fin Res Letters 103813.
39. UNCITRAL, Legislative Guide on Insolvency Law 220-221 (UN: New York, 2005).
42. Bankruptcy Code, 1978, USC, T 11, S. 506(a)(1).
43. Bankruptcy Code, 1978, USC, T 11, S. 727.
44. Bankruptcy Code, 1978, USC, T 11, S. 1129.
45. Insolvency Act, 1976, (UK) c. 45, Sch. B1 para 73, 1976
46. Insolvency (England and Wales) Rules, 2016, R. 14.19.
47. Companies Act, 2006, (UK), c. 46, S. 901-G.
48. Directive 2019/32/EC of the European Parliament and of the Council of 20-6-2019. On preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, 2019 OJ (L 172) 45.
50. Kaveri V.S., “Insolvency and Bankruptcy Code: A Banker’s Perspective”, (2018) 9 J. Commerce Mgmt Thought 319, 326.
51. Avikshit Moral, Ashish Mukhi and Kamlendra Pratap Singh, “Inter se Priority amongst Secured Creditors Under the Insolvency Regime in India: Striking the Right Balance—————”, (2020) 14 Insolvency and Restructuring Int’l 47-49
54. Ministry of Corporate Affairs, Report of the Expert Committee on Company Law (May 2005) p. 150.
55. Bankruptcy Law Reforms Committee, Interim Report (February 2015), pp. 93-96.
56. Government of India, Ministry of Corporate Affairs, Report of the Insolvency Law Committee (February 2020).
57. Shanya Ruhela, “Bombay’s Tryst with the City on Rhine”, (2020) 7 RGNUL Fin & Mercantile L Rev 85.
58. Aparna Ravi, “Indian Insolvency Regime in Practice: An Analysis of Insolvency and Debt Recovery Proceedings”, (2015) 50 Economic and Political Weekly 46, 48.
59. Hardeep Sachdeva, “Rights of First Charge-Holders Under IBC: A Perspective”, (AZB & Partners, 10-8-2021).
62. Government of India, Ministry of Corporate Affairs, Report of the Insolvency Law Committee, (February 2020) para 7.2.
63. Shruti Sethi, “The Third Party Security Conundrum Under IBC: Whether ‘Financial’ or Just ‘Secured’”, NLS Bus LR (21-6-2021).
65. Government of India, Ministry of Corporate Affairs, Notice on Invitation of Comments from the Public on Charges being Considered to the Insolvency and Bankruptcy Code, 2016, File No. 30/38/2021 — Insolvency dated 18-1-2023.